Avoid the 20% Penalty on
Accumulated Earnings
When C Corporations retain earnings beyond specific limits without a justified business purpose, the IRS may impose a penalty tax. Explore this interactive guide to understand your exposure and build a defense using the "Reasonable Business Needs" standard.
Statutory Safe Harbor Check
Every C Corporation has a lifetime exemption credit. Accumulated earnings below this threshold generally require no specific justification. Use this tool to see if you have crossed the line where the burden of proof shifts to you.
Corporation Data
Regular Corps have a $250,000 credit. Service Corps are strictly limited to $150,000.
Status: Assessing...
Adjust the values above to see your status.
Visual Risk Assessment
Comparison of your earnings vs. the statutory credit.
The "Bardahl" Defense Simulator
If you exceed the safe harbor, you must prove "Reasonable Business Needs." The courts use the Bardahl Formula to calculate how much working capital you are allowed to retain to cover one full operating cycle.
1. Inventory Cycle
How long cash is tied up in raw materials and goods before sale.
Longer cycle = More retention allowed.
2. Receivable Cycle
How long it takes to collect cash from customers after a sale.
Slower collection = More retention allowed.
3. Credit Cycle (Payables)
The time vendors allow you to pay bills. This acts as interest-free financing.
Longer terms = LESS retention allowed.
Operating Cycle Calculator
Adjust the sliders to match your business metrics. See how efficiency impacts your tax-free cash retention limit.
Note: Vendor credit reduces your need for working capital.
Calculated Peak Operating Cycle
Justifiable Retention
IRS Audit Red Flags
Beyond the math, the IRS looks for "intent." Specific behaviors signal to auditors that a corporation is being used as a personal pocketbook to avoid shareholder taxes.
Scrutiny Triggers (Click Segments)
Loans to Shareholders
This is the #1 audit trigger. If the corporation lends money to shareholders instead of paying dividends, the IRS argues the company clearly has excess cash it doesn't need for business. It appears as a disguised dividend.
Ensure all loans have formal written notes, charge market interest rates, and follow a strict repayment schedule.
Valid Defense Strategies
Bona Fide Expansion Plans
Plans to acquire a building, equipment, or another business.
Requirement: Plans must be "specific, definite, and feasible." Vague intent is not enough. Keep Board minutes and architectural blueprints.
Debt Retirement
Accumulating earnings to retire bona fide corporate debt is a valid reasonable need. This includes sinking fund requirements.
Stock Redemption (Section 303)
Accumulations to redeem stock of a deceased shareholder to pay death taxes and funeral expenses are protected under specific code sections.
Contingency Reserves
Reserves for specific, realistic risks such as pending litigation, self-insurance for uninsurable hazards, or potential loss of a major customer.